Demands from asset managers for a European legal framework for the transparency and distribution of structured products is dividing the market, with many sellside participants saying further regulation is unnecessary.

Regulation will not kill
structured products innovation

Ash

The row started after asset management lobby groups urged the European Commission to introduce rules governing the rapidly-growing structured products industry, to bring it more in line with investment funds regulation.

While sellside industry associations and several national regulators are opposing intervention by the commission, the buyside remains confident a proposal will be forged once the presidency of the Council of the European Union changes from Slovenia to France in the second half of this year.

So far there have been 80 responses to the commission’s call for evidence. There will be an open hearing in June/July based on the responses and a policy paper is likely to be released in October.

A senior banker in London said: “It could be seen as political. Once the presidency changes hands, the new legislation might get finalised. It is the French that are driving this thing.”

Not everyone agrees that it is a certainty.

Tim Hailes, managing director and associate general counsel of JP Morgan in London, said: “The call for evidence from the EC on regulation for structured products is carefully worded. There is no pre-defined agenda of any kind. It strikes the right tone.”

He said: “It is important to keep a sense of proportion. It is unlikely that the EU wants to go ahead with yet more directives in the wake of the markets in financial instruments directive. It will want to see the dust settle first. The burden of proof is on those that want to see change, not the other way around.”

There are several issues at stake in the debate. First is whether structured products should be treated and regulated in the same way as asset management funds.

Peter De Proft, the Brussels-based director-general of the European Fund and Asset Management Association, said: “All we are asking for is a level playing field. There is no way near the same level of disclosure and transparency for structured products as there is for asset management funds.”

De Proft said the call for change was not politically motivated: “This is just the first step in the process. This is how the EC does things. For sure there will be change. To say it is political is ridiculous. It is about fair competition.”

He added: “No one is saying that structured products and asset management are exactly the same but they can satisfy the same investment needs. In other words, they are in competition for the same business. That is why structured products are labelled substitute products. They perform a substitute role. As such they should be treated in the same way. It is only fair.”

Isda also challenges the notion that structured products and investment funds are interchangeable. For one thing, structured products are typically not long dated, unlike many investments in funds, it argues.

Metcalfe said: “Many people who invest in funds do it for the really long term, they are looking to set something aside for their retirement. Structured product investors are looking for something else, usually a strictly defined return within a shorter investment horizon.”

Also at stake is whether national regulators have the tools to regulate structured products themselves, without a supra-national directive to guide them.

This is especially important given that structured products are offered in different formats in different countries. The German market tends to wrap structured products in warrants. In Italy structured products are more closely linked to asset management.

In the UK, structured products have not been so successful because the market tends to like tax-exempt products such as individual savings accounts. Structured products do not get a favourable tax status in the UK.

There is also a debate about complex versus non-complex products, what constitutes the two and how best to regulate them.

Metcalfe added: “No lazy thinking can be done on this issue. While the mechanics behind a product can be complex, what it achieves can be simple. Does the investor need to know about the individual components that go into the structure? Not really. They want to know about the risks and the rewards.”

Fund managers, however, argue that investors must be able to understand the mechanics of any investment vehicle. De Proft agrees.

He said: “If people had understood the mechanics behind sub-prime then the situation might have looked different and they might have bought other products. There needs to be adequate access to the information. For structured products does the investor receive a daily net asset value? The answer is no. But they should.”

Isda believes that the banks already act responsibly in the selling of structured products and protecting their clients. Metcalfe said: “An investor takes a decision on risk. It is as simple as that. The real issue is how best to police distribution. But there are already processes for that.

“Moreover, an individual sale by a retail-facing firm may take place as part of a continuous relationship with the customer, rather than as an isolated transaction, in which there could be a whole series of conversations about a customer’s portfolio and its performance. This provides a good level of security for the customer.”

Some national regulators are also resisting European intervention, believing they are best positioned to police distribution of structured products in their country.

Tim Grange, a policy officer in the retail policy division at the UK’s Financial Services Authority, said: “It is not our business to regulate the shape of every product. We would be on a hiding to nothing with that.

“But we are in the best position to tackle issues relating to distribution since national markets are ultimately where any problems come home to roost anyway. It would be difficult to try to harmonise a regulatory framework for competing products. In practice Mifid is the new standard and any new regulation should operate within that standard.”

Meanwhile, sellside participants fear a supra-national directive could be damaging for product development, according to Hailes.

Metcalfe agreed: “The risks of getting it wrong are large. The demand for structured products is growing significantly.”

Lauren Ash, a director of equity derivatives and structured products at Citigroup Wealth Management in London, is less concerned. She said: “Tax is a significant economic driver for structured products. Even if there is regulatory change there will always be high demand from people looking for solutions that make sense from a tax perspective.

“The new regulation excludes tax so it will not kill the structured products market. The worlds of fund management and structured products are converging. And we are relaxed about convergence.”